Amid the Covid-19 uncertainty, figures suggest people are turning to cash rather than investing. But it could mean they’re missing out on potential, long-term returns. So, if you’re weighing up cash vs investing, which option is right for you?
In the first six months of 2020, UK households placed £77 billion in cash accounts, according to research from Janus Henderson Investment Trusts. In total, it takes cash reserves in the UK to £1.5 trillion. Saving more is certainly a positive habit. However, by choosing cash over investments, the same research estimates that households have missed out on £38 billion in returns, instead they’ve received just £5.7 billion in interest.
Why cash isn’t always a ‘safe’ option
There are many reasons why households have chosen to place their savings in a cash account. However, concerns over stock market volatility and feeling they need to keep their money ‘safe’ in the current climate are likely to have played a role for many.
While cash savings aren’t affected by investment risk, they don’t always make financial sense. Interest rates are at a historic low. This means, once you calculate inflation, cash savings are likely losing value in real terms. If you’re saving for a long-term goal, inflation can have a real impact on your savings.
The Bank of England’s inflation calculator highlights how inflation can erode cash value in the long term.
Let’s say you saved £10,000 in 1980. During the last four decades, inflation has averaged at 3.8% annually. This means that for your savings to have the same spending power as they did in 1980, they would need to have grown to £43,204.40. When interest rates were more competitive this may have been possible. But with many saving accounts offering rates far below the pace of inflation, your savings could effectively be losing money.
That’s not to say cash accounts shouldn’t be used. If you have short-term saving goals, they are often an appropriate option. Readily accessible accounts are also important for other reasons, such as an emergency fund.
However, the Janus Henderson Investment Trusts research indicates that some households are relying too heavily on cash accounts. To create an emergency fund of three months of income for households, this would amount to around £370 billion across the UK. Yet, there is almost an extra £1.2 trillion in cash accounts.
Could investing be right for you?
3 questions to ask when weighing up cash vs investing
1. Do you have an emergency fund?
Before you start investing, it’s important to create financial security. Setting up an emergency fund can create a buffer should anything unexpected happen.
Ideally, you should have three- to six- months of expenditure in a cash account. This means the money is readily accessible should you need it. It’s a step that can improve your ability to face financial shocks. It also means that should investments experience short-term volatility, you have other reserves that can be used rather than making withdrawals when values have fallen.
2. What are your goal timeframes?
Your goals and when you want to achieve them are incredibly important when balancing cash vs investing.
For short-term goals, cash accounts are usually more appropriate. This is because volatility is part of investing. With a short-term timeframe, you’re more likely to be affected by dips in the markets as you have less time to benefit from a recovery.
In contrast, investing for long-term timeframes (a minimum of five years) could be right for you. Longer timeframes provide an opportunity for the peaks and troughs of market movements to smooth out. While you’ll still experience volatility, there’s less risk that it will have a significant impact on your goals. This can mean if you’re saving for retirement or other aspirations that are still some way off, investing can potentially deliver higher returns than you’d see if you used cash accounts.
3. What is your tolerance for risk?
Finally, all investments come with some level of risk. You need to take this into account when deciding between cash and investing.
Your risk tolerance will need to take many factors into account. This includes what your goal is, but it should also weigh up other aspects, such as other assets that you hold, capacity for loss, and overall attitude to risk. By understanding these factors, you can not only decide whether investing is an appropriate option for you, but which investments you should select. These should reflect your situation but also need to consider things like diversifying.
If you have money and you’re not sure what to do with it or how to invest, we can help as your financial planner. Please contact us to discuss your goals and how we can help you achieve them.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.